Two significant cases were recently handed down which deal with the age-old debate of whether expenditure incurred is capital or revenue in nature. Fortunately, while most types of expenditure can easily be classified in this regard (e.g., the cost of purchasing business premises is capital, while rent paid for leasing the business premises is revenue), other types may be more challenging.
To assist taxpayers and tax practitioners alike, over the years, the courts have laid down a number of guidelines for distinguishing between capital and revenue outgoings.
One of the key factors in determining whether an outgoing is of a capital nature is to determine if it relates to the taxpayer’s ‘profit-yielding structure’. This requires an examination of whether the expenditure relates to the structure within which the profits are earned, or it relates to part of the money-earning process. Broadly speaking, in the absence of special circumstances, expenditure is capital in nature where it is made with a view to bringing into existence an asset or an advantage for the enduring benefit of the business.
Specifically, three elements have been identified as crucial to the distinction, although none is, in itself, decisive:
- The character of the advantage sought (its lasting qualities and recurrence may be relevant).
- The manner in which it is to be used, relied upon or enjoyed (recurrence may be relevant).
- The means adopted to obtain it (that is, by providing a periodical reward or outlay to cover its use or enjoyment for periods commensurate with the payment or by making a final provision or payment so as to secure future use or enjoyment).
Ultimately, the distinction comes down to whether the expenditure relates to the business entity, structure or organisation set up or established for the earning of profit; or the process by which such an organisation operates to obtain profits or losses.
For instance, some expenditure has features that support a finding that the expense is income in nature whilst also displaying features that indicate it is a capital expense, making the distinction even more difficult.
Note, all legislative references in this topic are to the ITAA 1997, unless otherwise indicated.
Hight Court finds gaming machine entitlements are not deductible
One important issue considered by the High Court (‘HC’) in Sharpcan’s case was whether the acquisition of gaming machine entitlements (‘GMEs’) by a gaming venue operator was on capital account, and therefore not deductible under S.8-1. Sharpcan’s case had progressed through the Administrative Appeals Tribunal (AAT’) (which found in favour of the taxpayer, that the expenditure on the GMEs was deductible, revenue expenditure) and the FFC (which also found in favour of the taxpayer) before being heard by the HC.
The HC overturned the decision of the lower courts and found in favour of the Commissioner, that is, that the expenditure on the GMEs was non-deductible, capital expenditure. That being the case, the HC considered whether the taxpayer was entitled to write the capital expenditure off over five years under S.40-880.
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